Recent data reported by the manufacturing and services sectors have been diametrically opposed in recent months. Whereas manufacturing data has signaled an economic slowdown in the US and abroad, largely due to the effects of the trade war, service sector data continues to report strong growth. This has added to the uncertainty about the future of global economic growth. The manufacturing sector is often viewed as a leading economic indicator so weak manufacturing data may foreshadow as recession. Meanwhile, the services sector represents a much larger percentage of total economic output and continues to report growth.
US manufacturing activity contracted in August following nearly three years of continuous expansion. According to the Institute of Supply Management (ISM) Report on Manufacturing, the August reading was 49.1 (any number below 50 denotes a decrease in manufacturing activity.) The detailed report shows many areas of concern. New orders, production, and employment all contracted. The hardest hit area was new export orders, a clear sign that the trade war is helping to weigh on the manufacturing sector.
The manufacturing woes in the US are a part of a global trend. The same surveys conducted in the UK, Germany, Japan, and South Korea have all been negative for a large part of 2019, although China did recently surprise the markets by reporting a small increase in manufacturing activity.
Global industrial production has been declining according to the most recent data with some countries being hit harder than others. While there has been a lot of attention given to the impact the trade war is having on the US and China, many other large exporters are suffering. For example, Japan and South Korea have reported double-digit percentage declines in exports to China.
Other data has confirmed the trends that are showing up in manufacturing data. Global trade has declined and many manufacturing companies are cutting investment in capital goods (the machinery and equipment required to manufacture goods). The fear is that this trend many continue and impact more and more countries should the trade war continue to escalate.
Meanwhile, the August services sector report issued by the ISM reported a strong headline number as well as strong growth in business activity and new orders. In fact, these data points not only showed strong growth but the rate of change also increased. It should be noted that the employment index also reported growth although the rate of increase slowed in August.
Given that nearly 80% of the US economy is attributable to services, the weak manufacturing report and strong services report may be a sign that the US economy can continue to grow in coming months. While the manufacturing sector has historically been a leading economic indicator it has also become less and less import for US employment and economic output. In addition, the weak manufacturing report may simply be a casualty of the trade war rather than an indication of broader economic weakness in the US. In this case, the US economic growth rate may continue at a low but positive rate if the services sector is able to offset the slump in global manufacturing activity.